Consumer Credit Cracks? Auto Loan Woes Signal a Bifurcated Economy

Recent stress in the auto finance space is raising early red flags for US consumer credit. Subprime auto lender Tricolor Auto Acceptance and auto parts supplier First Brand both filed for bankruptcy. And CarMax shares plunged on soft used car sales and rising loan delinquencies. Individually, these could be dismissed as isolated cases of poor underwriting. But together, they potentially reflect rising distress among subprime borrowers, even as the broader economy remains stable.

Over the past several years, consumers and businesses endured changes aimed at improving overall financial health while minimizing the likelihood of a repeat of the Global Financial Crisis (GFC). Many US households underwent a deleveraging process. The corporate sector refinanced into record-low interest rates after COVID and pushed the maturity wall further into the future. In addition, we also saw the tightening of regulations on bank lending. Now, aggregate consumer spending and net worth are holding up, buoyed by upcoming tax relief, interest rate cuts, and artificial intelligence (AI)-driven growth. Yet under the surface, a K-shaped economy is becoming more pronounced—where the financial health of wealthier households continues to improve while lower-income groups face growing strain.

Auto Loan Stress: A Harbinger of Broader Trouble?

While consumer spending has remained strong, especially in durable goods like autos, it may decelerate going forward. Real income compression due to inflation and tariffs, despite the Federal Reserve’s (Fed’s) renewed easing cycle in September, may drive the slowdown. Income growth is cooling, though wealth remains elevated and concentrated among top earners.

Subprime auto lending is showing clear signs of distress. Tricolor cited deteriorating repayment rates and tighter funding. First Brand noted falling used car demand and increasing defaults. CarMax, too, is seeing elevated delinquency rates and slower sales. While this subprime auto loan segment is not systemically large, only 16% of auto loan originations in 2024, according to New York Fed data, the rising stress is notable, and the divergence is clear. Prime borrowers remain stable while subprime delinquencies are climbing, an early sign of a credit cycle shift.

K-Shaped Divide: Credit, Income, and Age

1. Credit Divide: Prime versus Subprime

A widening split in auto loan performance is emerging, with subprime borrowers deteriorating while prime borrowers remain stable (Exhibit 1). Looser underwriting in 2022 and 2023 is evidenced by subprime loan books that are increasingly skewed toward high loan-to-value (LTV) and debt-to-income (DTI) loans, which are more prone to delinquency.

2. Income Divide: The Haves and Have Nots

Higher-income households continue to spend on travel, luxury goods, and services, thanks to wage growth, asset gains, and beneficial tax cuts. Consumers in the top 10% of the income distribution accounted for 49.2% of total spending, according to March 2025 research by Moody’s. Additionally, 70% of net worth is concentrated in the top 20% of income groups (Exhibit 2).

In contrast, lower-income consumers are under pressure. Essentials, including food, rent, and transit, are costlier due to higher inflation and slower wage growth (Exhibit 3). Other pressures include cuts to social programs, tariffs, and increased dependence on “buy now, pay later” (BNPL) schemes and credit cards.

3. Age Divide: Old versus Young

Over 70% of total net worth is concentrated in the 55+ age group (Exhibit 4). Older cohorts benefit from resilient household balance sheets boosted by massive home equity accumulation, low-rate mortgages, stronger savings, and lower debt loads. In contrast, younger Americans are particularly vulnerable due to student loan debt, unattainable homeownership, and an at-risk entry-level job market due to AI automation.

Contagion Watch: Four Leading Indicators

The consumer credit market appears stable on the surface, but watch these indicators for signs of systemic stress as a result of the increasing demographic and economic bifurcations (Exhibit 5):

• High Yield CCC Bond Spreads: Rising spreads signal deteriorating investor sentiment toward the riskiest borrowers.
• Private Equity Stocks: Underperformance may reflect some distress and the ensuing tightening of lending in private credit markets and leveraged loans.
• US Bank Index: Regional banks are closely tied to consumer credit. Weaknesses here could indicate rising consumer loan losses or deposit pressures.
• Asset-backed Securities (ABS) Spreads: Widening spreads on auto loan and credit card-backed securities reflect investor anxiety over consumer credit quality.

So far, we have seen private equity stocks underperforming and a slight decline in regional bank stocks. Meanwhile, the other two indices are still benign. However, a coordinated move across all four metrics would suggest that today’s localized stress is turning systemic.

Conclusion: Stay Quality-Focused, Stay Vigilant

The overall consumer picture remains fairly strong due to high household wealth, low unemployment, accommodative financial conditions, and solid economic growth supported by monetary easing, tax cuts, and AI-driven investment. But cracks are showing, especially among subprime borrowers, the young, and the low-income cohort. The risks remain localized for now, but credit cycles often start with strain on the margins before expanding.

Investment implications:

• Favor Up-in-quality: We are focused on senior and investment-grade tranches of capital structures and companies with strong balance sheets, pricing power, and exposure to higher-income consumers.
• Avoid Troubled Lenders: We generally seek to avoid investing in overlevered or subprime-focused lenders with weak underwriting standards and sponsorship.
• Watch the Indicators: We are carefully monitoring economic and consumer credit indicators. If they move together, the next leg down in the credit cycle may be near.
• Hedge Opportunistically: Given historically tight credit spreads, low volatility, and hedging costs, we are looking to hedge opportunistically.

Right now, the risk signals are flashing amber, not red. We are likely still mid-cycle in the credit market, given that households and the corporate sector have not yet seen excessive leverage, but early awareness is key.

Index Definitions

The ICE BofA CCC & Lower U.S. High Yield Index is a subset of the ICE BofA US High Yield Master II Index, which tracks the performance of U.S. dollar-denominated below investment grade-rated corporate debt publicly issued in the U.S. domestic market. This subset includes all securities with a given investment grade rating CCC or below.

The Invesco Global Listed Private Equity ETF will invest at least 90% of its total assets in securities, including American depositary receipts (ADRs) and global depositary receipts (GDRs) that comprise the underlying index. The underlying index is composed of securities, ADRs, and GDRs of 40 to 75 private equity companies, including business development companies, master limited partnerships, alternative asset managers, and other entities that are listed on a nationally recognized exchange.

The KBW Nasdaq Bank Index is a modified market capitalization-weighted index designed to track the performance of the leading banks and thrifts that are publicly-traded in the US. The Index includes 24 banking stocks representing the large US national money centers, regional banks, and thrift institutions.

The ICE BofA US Fixed-Rate Asset-Backed Securities Index tracks the performance of US dollar-denominated, investment grade fixed-rate asset-backed securities publicly issued in the US domestic market.